The Libor scandal and its implications

By William Arnold

In late June, Barclays announced record regulatory fines of £290m for misconduct in relation to its Libor and Euribor submissions in the period from 2005 to 2009. Further to this, last week there were press reports that US prosecutors have sent subpoenas to seven institutions, including Barclays, Citigroup, Deutsche Bank, HSBC, JPMorgan, RBS, and UBS.

Background

The London Interbank Offered Rate (Libor) and its Brussels equivalent (European Interbank Offered Rate (Euribor)) are set by the British Bankers' Association (BBA) through a process whereby each day about 40 banks submit their interest rates at which they are willing to lend to organisations in their regions. Once the high and low bids are discarded, the rates of the two middle quartiles are arithmetically averaged. This process is repeated about 150 times to determine the final rates each day. The interbank offered rates serve as a reference for the pricing of financial products worth some US$350tr.

Barclays and allegedly other banks during the 2007-2009 period took into account traders' requests to submit manipulated Libor rates as a way to boost traders' profits or benefit the banks' portfolios (see article "Barclays in the wake of the Libor scandal" for more information on Barclays). To date banks named in various investigations include Citigroup, UBS, RBS, JPMorgan, Credit Suisse, Lloyds, Deutsche Bank, Credit Agricole SA, Societe Generale, and HSBC. Another bank named in local press was Rabobank. In general banks have been unwilling to comment on the status of either internal or regulatory investigations.

Not a new phenomena

Questions about rate fixings are not new:

The New York Federal Reserve released documents in 2012 which showed as far back as 2007 that they were aware that banks were lying about their borrowing costs when setting Libor and chose to take no action against them at that time. Released minutes from the Bank of England indicated similarly that the bank and its deputy governor Paul Tucker were also aware as early as November 2007 of industry concerns that the Libor rate was being underreported

In May 2008, The Wall Street Journal released a study suggesting that some banks might have understated borrowing costs they reported for the Libor during the 2008 credit crunch that may have misled others about the financial position of these banks

In March 2008 the Bank for International Settlements also noted similar issues. By the end of 2008, the Governor of the Bank of England, Mervyn King, described Libor to the UK Parliament saying "It is in many ways the rate at which banks do not lend to each other, ... it is not a rate at which anyone is actually borrowing"

In 2011 UBS and Citigroup were ordered by the Japanese regulator to suspend some of their operations as a result of questions surrounding their rate-setting

Impact on banks

It is likely that fines imposed by regulators will be manageable in the context of most banks' earnings power. The bigger risk exposure is from litigation costs from parties believed to have been impaired by the Libor manipulation - a legal process which could drag out over many years. It could however be difficult to prove damages. In order to do so, litigants may essentially have to prove what the 'correct' Libor rate should have been.

Impact on the Libor-setting process

The British Bankers' Association (BBA) was already reviewing changes to the daily process for generating Libor, primarily looking to enhance its calculation process as a way to deter traders from trying to manipulate rates. The UK Financial Services Authority (FSA) has now also started an investigation after the Barclays revelations. The FSA review will likely question whether UK authorities should strip the BBA of its responsibility for overseeing Libor setting, and whether these rates should all be set in London. The FSA expects to report to the government by the end of September.

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Director - Credit Research, Industrials and Corporates. Will has over 15 years’ experience in credit and fixed income markets, including 6 in London, working at fund managers, banks and government treasury.

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